Lombard Street: A Description of the Money Market

by Walter Bagehot

Large Format for easy reading. By the nineteenth century British economist and author of The English Constitution. A valuable financial work.

Genres: Economics, Finance, History, Nonfiction, Banking, Business, Money

188 pages, Paperback

First published January 1, 1873

About the author

British journalist Walter Bagehot edited The Economist and wrote The English Constitution (1867), an analysis of the comparative powers of the branches of government.

Walter Bagehot, a businessman and essayist, extensively covered literature and affairs.

https://en.wikipedia.org/wiki/Walter_...

Reviews

[Mehrsa · Rating 5 out of 5]

I've read bits and parts of this, but I just read it start to finish and I learned a lot. Most of Bagehot's insights helped form the structure of the Federal Reserve, but we still seem to forget some of his ideas. For example, that panics are primarily about a lack of trust. The book explains how modern banking works and how the central bank should act during crises.

[Steve · Rating 3 out of 5]

Lombard Street is an early call for prudent national banking policies, especially regarding the provision of liquidity during a financial panic. This work can be summarized with three concepts: (1) banks should always carry sufficient reserves, (2) the central bank – in this case the Bank of England – should loan against “all good banking securities, and as largely as the public ask for them,” and (3) a sufficiently high rate of interest should be charged against loans to “operate as a heavy fine on unreasonable timidity, and will prevent the greatest number of applications by persons who do not require it.”

While Mr. Bagehot’s cautions merit repetition, times have changed; the world moved away from the gold standard to paper currencies that now function in constant competition. It’s an ugly picture for sure with the masters of the Dollar, Yen, Euro and lesser currencies conspiring to lower interest rates and create financing schemes, without destroying confidence in their fiat money, all with the objective of maximizing employment and economic vibrancy. I think it fair to say the word ‘prudent’ can no longer be combined with the words ‘central bank,’ at least with respect to the largest economies. Yet, there appear to be no consequences. Ah, something tells me Mr. Bagehot would warn us of plenty of consequences, all unpleasant; the trigger will revolve around the word ‘confidence.’

[Al Maki · Rating 4 out of 5]

This little book, published in 1871, describes the functioning of the first great capital market at the time when money first began to flow quickly and easily across distances and borders to wherever it would be most profitable to those who controlled it. (I suspect the telegraph played a role in this transformation.) Bagehot confined himself to describing the workings of the actual money market, intentionally keeping clear of economic theory. The fact he named the book after the specific street where the activities took place is indicative. Although conditions have changed greatly since he wrote, the book presents a good introduction to the mechanisms of capital.
The latter part of the book points out weaknesses in the then current workings of the money market that resulted from London having become an international centre for capital and it proposes methods of safe guarding against a panic. I think it demonstrates his astuteness that he was arguing this in 1871 two years before "The Panic of 1873" that triggered the "Long Depression", the first global depression, lasting twenty years.
He was one of those uncommon writers who are able to express complexity clearly. I wish I could find somebody writing about money today with his skill as a writer, his knowledge (before becoming a journalist he had worked as a banker) and his scrupulous avoidance of economic dogma.

[Justin Tapp · Rating 4 out of 5]

Lombard Street: A Description of the Money Market by Walter Bagehot (1873, reprinted by Project Gutenberg).
This is the original book about bank runs, financial crises, and the role of a central bank. This is on Ben Bernanke's short-list of recommended books, and he quotes Bagehot often. Bagehot influenced those who would later create the Federal Reserve.

Bagehot is examining the British financial system, then the biggest and most well-capitalized in the world. (Known deposits in London in 1873 were 120,000,000 pounds, while New York was next with the equivalent of 40,000,000 pounds). The capital had done wonders for British industrial development, as a properly functioning financial market is necessary for any advanced country. But risk is inherent:

"The peculiar essence of our banking system is an unprecedented trust between man and man: and when that trust is much weakened by hidden causes, a small accident may greatly hurt it, and a great accident for a moment may almost destroy it."



England had recently (1866) gone through a panic very similar to our recent financial crisis, the Overend Gurney crisis, where some very large players dealing with risky schemes and assets went bust and triggered a panic, handled controversially by the Bank, which suspended payments as the system collapsed.
Bagehot on Overend, Gurney, and Co.:

"(T)hese losses were made in a manner so reckless and foolish, that one would think a child who had lent money in the City of London would have lent it better."


The Bank hasn't always done a bad job of being the lender of last resort, and Bagehot gives a good bit of interesting history.

The Bank of England was privately owned and operated by a large board of executives from various types of industry. It had a rotating presidency and governorship (which Bagehot actually recommends eliminating for a permanent governor and vice-governor) who seemed to run the bank well and rather conservatively. The Bank of England held deposits from all the other banks on Lombard Street as well as the British Exchequer, and foreign governments.


In 1844, Parliament gave the Bank of England exclusive authority to issue notes (ie: currency), so long as they were 100% backed by gold (a rule the Bank could suspend during a crisis). The Act also created a fractional reserve banking system in the U.K., with no required reserve ratio. The Bank of England was the bedrock of the system, and it typically kept a very large reserve as a result. Bagehot gives a lot of insight and praise into its conservative governorship, but suggests it be even more conservative.

Bagehot much prefers the British system to the American, which had just nationalized the currency after the Civil War. He deplores the 2-charter U.S. system with its different regulators required to keep tabs on what banks are doing. There are some interesting comments seemingly in favor of free banking, which I found interesting. Bagehot

Bagehot's role for a central bank during a panic is to:
1. Before the panic, build up a large reserve.
2. During the panic, lend freely, at high rates of interest, and on good collateral.

"A panic...is a species of neuralgia, and according to the rules of science you must not starve it. The holders of the cash reserve must be ready...to advance it most freely for the liabilities of others."



The high rate of interest is to penalize the bad banks who can't afford the loan. Here, he is unaware of the concept of adverse selection--those who will borrow at high interest rates are more likely to be the bad banks, not the sound ones. He makes the point earlier in the book that a bank or creditor in trouble will pay any price for money rather than go broke, but seemingly misses the connection here.

The collateral is important, it needs to be what Gorton would call "information insensitive," something everyone recognizes is most likely a good asset--bank loans, for example. If everyone sees the bank lending freely on decent collateral, then they will stop panicking. These are the days before deposit insurance.

All banks during a bank run need to lend more, not less. Otherwise, people will think they don't have enough money to meet their obligations and the run will intensify-- wiping out good banks as well as bad. The best modern day illustration of this from the Great Depression was in Episode 3 of Milton Friedman's Free to Choose series, I show it to Money and Banking every year.

Another aspect that Bagehot deals with is joint stock companies and the principal-agent problem. He totally identifies that managers and owners may have conflicting incentives. His suggestion is that the members of the board of directors with the most "spare time" basically micromanage the manager's decisions to make sure he's not engaging in overly risky behavior.

Bagehot describes the speculation that happens just before a panic, reminiscent of our housing boom/bust:

"The good times too of a high price almost always engender much fraud. All people are most credulous when they are most happy; and when much money has just been made...when most people think they are making it, there is a happy opportunity for ingenious mendacity."

Another good quote:

"I am by no means an alarmist. I believe that our system, though curious and peculiar, may be worked safely; but if we wish so to work it, we must study it...Money will not manage itself, and Lombard Street has a great deal of money to manage."

I enjoyed this book and consider it a must-read for students of money, banking, and financial crises. I have one more book on my crisis reading list to finish before the semester starts.

[Arbraxan · Rating 3 out of 5]

In a crisis lend freely and against good collateral at a high rate of interest. Straight from the 1870s but as valid today as back then, this is Bagehot's recommendation to central bankers all around the world. They are the financial system's last reserve and through that special status bear responsibility for acting as the system's lender of last resort. The chapters on the Bank of England are rather interesting, but some descriptions of Lombard Street's inhabitants - bill brokers, private bankers, joint stock companies, and the like - might be most of interest to historians.

[Nilesh Jasani · Rating 5 out of 5]

Lombard Street is a much-needed, jargon-free treatise for those thinking about the viability of the cryptos, defi, and the like. While the messages here do not rule out a decentralized financial system without a lender of last resort or a centralized policymaker/rule-setter, the book will provoke many thoughts and spawn ideas in the minds of both their believers and skeptics.

Of course, the nineteenth-century authored book is simply the work of a genius; this aptly celebrated, landmark work helped found the first central banks and has influenced central banking ever since. Walter Bagehot's clarity of thoughts and writing in this book must have helped quash many needless policy debates before they reared their heads for decades while shaping conversations in many other directions.

For instance, the book cleared the way for the emergence of a central, government-owned, non-profit, competent person (as against a minister aka politician) led lender of last resort across the world. The book makes a comprehensive case for countercyclical policies by this institution in times of deep distress. It equally provides solid justifications for various lending or liquidity rules during normal times. As a result, the needs behind capital adequacy norms, reserve requirements, or central bank liquidity supporting/moping operations have rarely been debated even in highly non-capitalist systems until the arrival of the crypto crowd in recent times.

It may not matter how much of it all started with this book and the author to current readers. The leading utility of the book is in all its indirect messages when repurposed. The strongest crypto believers are highly dismissive of central banks for their fiat money issuer role. In some ways, the book has nothing on fiat currencies as it was published for a system that believed in the gold standard. Yet, the path paved here (by establishing the central banking processes that need the creation of reserves - aka money - from nothing when times are tough) was invariably going to lead to the emergence of fiat currencies a few decades hence.

That said, the book is the most lucid evidence of how history has been rather than the way many modern decentralized system proponents paint it. Centralization - through the central banks - was not borne out of the desire to print an unlimited amount of money or to invade anyone's privacy or because the intermediaries wanted to make more money. It happened because the decentralized financial world of the mid-nineteenth century (and before) had too volatile cycles borne out of regular market/liquidity/confidence forces. These cycles that first manifested themselves in money market flows and prices had to be pruned before they became circular and wreaked far more real-life damage when allowed to go on unchecked. As the author knew then and we all know now, central institutions like central banks do not solve all problems at all times, plus they come with their own "side effects," but a world without such institutions and attendant rules existed before this book was far worse.

Once again, this jargon-free book was the first paper that showed why a central institution was needed to bring order to a completely decentralized financial system that existed at the time. It was like that era's Satoshi paper! This reviewer cannot imagine how a decentralized system without such an institution can function for long in real life with repeated confidence and liquidity extremities that are a regular feature in trading markets. Real-life with real people and activities cannot afford impacts arising from unchecked financial gyrations because of the vicious cycles/circularities they create. Maybe, there is a decentralized system possible without such gyrations, but that's not what the crypto crowd is attempting to create when they discredit the current centralized system for its money printing and privacy-related flaws.

[Juanoprivot · Rating 4 out of 5]

Sin duda, un buen manual de política del Banco Central(como reserva única del país) para hacer frente a los pánicos bancarios.

Me encanta cuando menciona su ideal de sistema bancario: un sistema "natural" que claramente hace referencia al concepto de Hayek de orden espontáneo.

[Ben Peyton · Rating 5 out of 5]

I thought this was a very interesting book on the history of the money markets and the Bank of England and the need for a lender of last resort in financial markets. I was a little worried that the book would be overly dry or written in a style that I wouldn't understand because it is from the late 1900s. I was surprised by how light the writing style was and it was really easy to follow.

I think the main argument that Bagehot makes is that in a time of crisis when credit or liquidity dries up you need a central bank that will lend money easily and quickly. For that to happen a the bank needs adequate reserves to lend and so figuring out the amount of those reserves seems more art than science. This seems to be his main argument but it's probably not even applicable anymore. The structure of the Bank of England is probably different now and the Federal Reserve is very different. But the basic idea I think applies - when in a crisis you need a central bank that will lend money freely to protect against a crisis getting worse.

The book also has some very good chapters on the different entities that make up the money markets at the time. All of it is historical now but the basic ideas still apply.

[Eugene Kernes · Rating 3 out of 5]

This book is a reaction to the amount of funds, the amount of debt that has become available at Lombard Street. So much money was available to lend and so much was borrowed that it seemed that everyone could get money if they were willing to pay enough for it. Banks acting as intermediaries between those who have money and those that need money. Lombard Street being a central location of the 19th century that comprised many banking institutions. With so much debt, and the economy being very interdependent, a need a rose for a reserve fund, what is now called a central bank. With a goal of reducing panic and crisis, but comes at a price of changing incentives and containing functions that can exacerbate the crisis.

A basic foundational fact about banking is that the institutions are depend on borrowed money. Credit means confidence and trust given. Banking acts as an intermediary between firms that are on the rise in which money can be easily employed, and firms which are stationary or declining that have more money that than can be used. Borrowed money enhances the ability of the firm to produce. From providing funds to start ventures, and also to lowering prices below those who are relying on just on their own money.

With so much borrowed money comes the risk that the banking and industrial system would be in danger if enough people demanded money. Each industry is connected to others by the purchases they make. Should an industry have economic problems, the problems will reverberate to other industries. Prudent banks will save reserve money during normal times, to use in exigent times. Credit is a system that cannot easily be brought up. Breaking the system of credit will destabilize the economic system. There will be a long wait for a successor system.

Due to the danger of an unexpected increase in demand for money from banks, a reserve fund is to lend that money needed to be established. Setting up a reserve found has many perils such requiring state aid, reduces incentive for banks to save money, depended on a single individual or group for decision making rather than the average wisdom and folly of competitors, and can be pressured by board of directors for high dividends which require a small reserve. There are many unexpected events and accidents that can cause a panic to the credit system, but a central bank needs to be prepared for all of them by keeping a large cash reserve.

During a time of crisis, the central bank’s goal is to reduce the alarm, and not do more to exacerbate the alarm. To do this, the central bank needs to lend vigorously. A high interest rate for the loans prevents those who do not need the money from obtaining more money, and acts as a fine on unreasonable timidity. Loans based on good securities should all be made. To refuse a loan based on good securities would be cause other loans from being fulfilled thereby exacerbate the panic. What qualifies as good securities is the same qualifications during normal times, easily convertible assets to solvent merchants. Simple rules tend to be uniform and can cause more problems than they fix because the dangers faced are complex and many.

This book was written when the Bank of England was taking on the responsibilities of central banking. The lessons derived from this book are present in the 21st century, but there are also many adjustments. The writing of the book is not always smooth and has poor transitions, and contains many antiquated terminologies. Some of the arguments are contradictory and are not fully explained.

[Darius · Rating 4 out of 5]

Walter Bagehot was editor of "The Economist" in the 1860s. In "Lombard Street: A description of the money market" he explains the workings of British fractional reserve banking system of his time, under a gold-standard currency. Bagehot provides a lot of interesting tid-bits about the founding and evolution of banking. Of most relevance to today is his explanation of the benefits and dangers of fractional reserve banking and his recommendations of how to best manage a flawed system that has a single central-bank.

The Bank of England, then private, was the de facto central bank. Bagehot laments the statism that put the bank in this position. However, he thinks it is quixotic to think that the fundamental British structure can be changed.

Of course any man-made institution can be changed. Nevertheless, within the scope of his assumption, he makes sensible suggestions for managing a central bank. In today's world of powerful central banks Bagehot's book is relevant again.

Fractional reserve banking monetizes an array of assets: Bagehot contrasts Britain's system with other European ones. In a fractional reserve system, deposits of gold are slowly converted into other materials -- factories, railways and so on, with only a fraction actually remaining in the form of gold, even though the whole of it is subject to a promise to be paid out in gold "on demand". Whatever one might think of the fragility (or even the honesty) of such a system, it does have some advantages.Each bank-note represents a de jure claim to gold, but it represents an indirect de facto claim to productive assets. Instead of monetizing gold alone, it monetizes houses, ships, inventories, toll-roads, etc.

A store of value: One role played by money is as a "store of value". In a fractional-reserve system, productive assets are used as a store of value. Over time, such assets create more value by being put to some use. Two decades later, even though the original machines may be worn and gone, some part of the value produced would have been re-invested in newer machines, in different factories, and so on. The value would have been stored and increased, even though it would have changed physical form.

This, notes Bagehot, is the huge benefit of the British system of banking. He says, "...much more cash exists out of banks in France and Germany, and in all non-banking countries, than could be found in England or Scotland, where banking is developed. But that cash is not, so to speak,...attainable. ... ... the English money is 'borrowable' money."

Borrowing and Class mobility: In addition to using productive assets as a store of value, this ability to borrow also allows the faster rising of a class of entrepreneurs who do not have sufficient capital of their own. "it prevents the long duration of great families of merchant princes, such as those of Venice and Genoa, who inherited nice cultivation as well as great wealth, and who, to some extent, combined the tastes of an aristocracy with the insight and verve of men of business. These are pushed out, so to say, by the dirty crowd of little men."


Problems loom: Bagehot is quite aware of the problems with the English system of fractional-banking: "in exact proportion to the power of this system is its delicacy". It's impossible for individuals to examine and understand the assets and capital structure of every bank whose notes they accept. Since non-gold assets are monetized, these assets may unexpectedly lose value. A bank that has lent unwisely can end up insolvent.

Further, even if the loans are good, the duration-mismatch is a problem (i.e. the bank has promised to pay out cash "on demand", but cannot call in its loans in short order). If there is an unexpected rise in the demand for money, the money may not be there. "The 'cotton drain,' as it is called—the drain to the East to pay for Indian cotton during the American Civil War took many millions from [Britain] for a series of years." Even a very solvent bank could be illiquid: it can pay its depositors eventually, but not if they want their money now.

Dealing with Bank runs: From the experience of bank-runs, Bagehot came up with principles a central bank ought to use. He recommends larger fractions be held as reserves by individual banks. For the central bank, he has this advice:
Do not help insolvent banks. Instead, recognize their situation and treat them like any bankrupt. "The cardinal maxim is, that any aid to a present bad Bank is the surest mode of preventing the establishment of a future good Bank."
Help solvent banks by lending large amounts freely. A panic will not be stemmed by tiny modicums of liquidity.
Charge penalty rates for rescuing a illiquid but solvent bank (of course this means that the bank is solvent even given the margin for error and the high penalty rates). "Very large loans at very high rates are the best remedy for the worst malady of the money market when a foreign drain is added to a domestic drain."

High rates pull money back into the banking system, and draw gold from abroad. If the assets are truly good, there is some rate at which people will be induced to keep their money in the banking system -- even if they shift it from one bank to another. "If the interest of money be raised, it is proved by experience that money does come to Lombard Street,..." These days, the Fed violates the principle of not lending to insolvent banks, and also the principle of raising rates. Instead, rates are lowered at such times.

Summary: This book is not for readers with only a casual interest in the subject, but it is a good source for those who are interested in the history behind our current system, and a great discussion for anyone studying fractional-reserve banking. Few will agree with all Bagehot's advice, but the book offers much wisdom to ponder. A must-read for any serious student of banking.

[Nate · Rating 4 out of 5]

Good essential reading albeit outdated. Solid primer for central banking topic as a whole.

[Sara K]

Very interesting how it is a product of its time, and yet still holds some relevance today.

[Will · Rating 2 out of 5]

"Nothing, therefore, can be more certain than that the Bank of England has in this respect no peculiar privilege; that it is simply in the position of a Bank keeping the Banking reserve of the country; that it must in time of panic do what all other similar banks must do; that in time of panic it must advance freely and vigorously to the public out of the reserve.

And with the Bank of England, as with other Banks in the same case, these advances, if they are to be made at all, should be made so as if possible to obtain the object for which they are made. The end is to stay the panic; and the advances should, if possible, stay the panic. And for this purpose there are two rules: First. That these loans should only be made at a very high rate of interest. This will operate as a heavy fine on unreasonable timidity, and will prevent the greatest number of applications by persons who do not require it. The rate should be raised early in the panic, so that the fine may be paid early; that no one may borrow out of idle precaution without paying well for it; that the Banking reserve may be protected as far as possible.

Secondly. That at this rate those advances should be made on all good banking securities, and as largely as the public ask for them. The reason is plain. The object is to stay alarm, and nothing therefore should be done to cause alarm. But the way to cause alarm is to refuse some one who has good security to offer. The news of this will spread in an instant through all the money market at a moment of terror; no one can say exactly who carries it, but in half an hour it will be carried on all sides, and will intensify the terror everywhere. No advances indeed need be made by which the Bank will ultimately lose. [...] If it is known that the Bank of England is freely advancing on what in ordinary times is reckoned a good security - on what is then commonly pledged and easily convertible - the alarm of the solvent merchants and bankers will be stayed."

[Fred Kohn · Rating 3 out of 5]

My motivation for reading this book was a rereading of A History of the Federal Reserve, Volume 1: 1913-1951, especially chapter two, dealing with monetary theory in the 18th and 19th centuries. Not having sufficient economic background to get through this chapter the first time around, I had to go read John Chown's books on money before I was able to get through this chapter and the book. Now that I am reading it for the second time, I noticed Walter Bagehot's classic mentioned approvingly. Since the book seemed short enough, I gave it a go. It is a much easier read than The Wealth of Nations, which I have been butting my head against for at least the past three years. The only downside is that there are large swatches of the book that are only of historical interest.

[Isaac Chan · Rating 3 out of 5]

Considering that this book is so heavily endorsed and adored by central bankers around the world, I am not going to pretend that I was not slightly disappointed by its content. The book revolves around principles that should ought be second nature to any individual with the slightest interest in the financial markets, such as free lending by the central bank in times of a financial crisis, and I would deem it slightly exaggerated to label this book as the bible of central banking. But then, I presume that these principles was not known to the general public before the publishing of this book, so I suppose I should not be so harsh on my review.

[Jeff · Rating 4 out of 5]

Big Walt nails it here.

[James · Rating 4 out of 5]

still probably the clearest look at these dang money markets and what it is theyre up to

[Rommel Harlequin Monet · Rating 5 out of 5]

(1873)

The briefest and truest way of describing Lombard Street is to say that it is by far the greatest combination of economical power and economical delicacy that the world has ever seen.
Of the greatness of the power there will be no doubt. Money is economical power. Every one is aware that England is the greatest moneyed country in the world; every one admits that it has much more immediately disposable and ready cash than any other country. But very few persons are aware how muck greater the ready balance—the floating loan-fund which can be lent to any one or for any purpose—is in England than it is anywhere else in the world. A very few figures will show how large the London loan-fund is, and how much greater it is than any other. The known deposits—the deposits of banks which publish their accounts—are, in

London (31st December, 1872) . . . £120,000,000

Paris (27th February, 1873) . . * 13,000,000

New York (February, 1873) • • • 40,000000

German Empire (31st January, 1873) • 8,000,000

And the unknown deposits—the deposits in banks which do not publish their accounts—are in London much greater than those in any other of these cities. The bankers’ deposits of London are many times greater than those of any other city—those of Great Britain many times greater than those of any other country.*

Of course the deposits of bankers are not a strictly accurate measure of the resources of a Money Market. On the contrary, much more cash exists out of banks in France and Germany, and in all non-banking countries, than could be found in England or Scotland, where banking is developed. But that cash is not, so to speak, “ Money Market money ”: it is not attainable. Nothing but their immense misfortunes, nothing but a vast loan in their own securities, could have extracted the hoards of France from the custody of the French people. The offer of no other securities would have tempted them, for they had confidence in no other securities. For all other purposes the money hoarded was useless and might as well not have been hoarded. But the English money is " borrowable” money. Our people are bolder in dealing with their money than any continental nation, and even if they were not bolder, the mere fact that their money is deposited in a bank makes it far more obtainable. A million in the hands of a single banker is a "great power; he can at once lend it where he will, and borrowers can come to him, because they know or believe that he has it. But the same sum scattered in tens and fifties through a whole nation is no power at all: no one knows where to find it or whom to ask for it. Concentration of money in banks, though not the sole cause, is the principal cause which has made the Money Market of England so exceedingly rich, so much beyond that of other countries.

The effect is seen constantly. We are asked to lend, and do lend, vast sums, which it would be impossible to obtain elsewhere. It is sometimes said. that any foreign country can borrow in Lombard Street at a price; some countries can borrow much cheaper than others; but all, it is said, can have some money if they choose to pay enough for it. Perhaps this is an exaggeration ; but confined, as of course it was meant to be, to civilised Governments, it is not much of an exaggeration. There are very few civilised Governments that could not borrow considerable sums of us if they choose, and most of them seem more and more likely to choose. If any nation wants even to make a railway—especially at all a poor nation—it is sure to come to this country— to the country of banks—for the money. It is true that English bankers are not themselves very great lenders to foreign states. But they are great lenders to those who lend. They advance on foreign stocks, as the phrase is, with " a margin ”: that is, they find eighty per cent, of the money, and the nominal lender finds the rest. And it is in this way that vast works are achieved with English aid which but for that aid would never have been planned.

In domestic enterprises it is the same. We have entirely lost the idea that any undertaking likely to pay, and seen to be likely, can perish for want of money; yet no idea was more familiar to our ancestors, or is more common now in most countries. A citizen of London in Queen Elizabeth’s time could not have imagined our state of mind. He would have thought that it was of no use inventing railways (if he could have understood what a railway meant), for 3^ou would not have been able to collect the capital with which to make them. At this moment, in colonies and all rude countries, there is no large sum of transferable money; there is no fund from which you can borrow, and out of which you can make immense works. Taking the world as a whole—either now or in the past—it is certain that in poor states there is no spare money for new and great undertakings, and that in most rich states the money is too scattered, and clings too close to the hands of the owners, to be often obtainable in large quantities for new purposes. A place like Lombard Street, where in all but the rarest times money can be always obtained upon good security or upon decent prospects of probable gain, is a luxury which no country has ever enjoyed with even comparable equality before.

But though these occasional loans to new enterprises and foreign states are the most con¬ spicuous instances of the power of Lombard Street, they are not by any means the most remarkable or the most important use of that power. English trade is carried on upon borrowed capital to an extent of which few foreigners have an idea, and none of our ancestors could have conceived. In every district small traders have arisen, who “ discount their bills ” largely, and with the capital so borrowed, harass and press upon, if they do not eradicate, the old capitalist* The new trader has obviously an immense advantage in the struggle of trade. If a merchant have £50,000 all his own,—to gain 10 per cent, on it he must make £5000 a year, and must charge for his goods accordingly ; but if another has only £10,000, and borrows £40,000 by discounts (no extreme instance in our modern trade), he has the same capital of £50,000 to use, and can sell much cheaper. If the rate at which he borrows be 5 per cent., he will have to pay £2000 a year; and if, like the old trader, he make £5000 a year, he will still, after paying his interest, obtain £3000 a year, or 30 per cent., on his own £10,000. As most merchants are content with much less than 30 per cent., he will be able, if he wishes, to forego some of that profit, lower the price of the commodity, and drive the oldfashioned trader—the man who trades on his own capital—out of the market. In modern English business, owing to the certainty of obtaining loans on discount of bills or otherwise at a moderate rate of interest, there is a steady bounty on trading with borrowed capital, and a constant discouragement to confine yourself solely or mainly to your own capital.

This increasingly democratic structure of English commerce is very unpopular in many quarters, and its effects are no doubt exceedingly mixed. On the one hand, it prevents the long duration of great families of merchant princes, such as those of Venice and Genoa, who inherited nice cultivation as well as great wealth, and who, to some extent, combined the tastes of an aristocracy with the insight and verve of men of business. These are pushed out, so to say, by the dirty crowd of little men. After a generation or two they retire into idle luxury. Upon their immense capital they can only obtain low profits, and these they do not think enough to compensate them for the rough companions and rude manners they must meet in business. This constant levelling of our com¬ mercial houses is, too, unfavourable to commercial morality. Great firms, with a reputation which they have received from the past, and which they wish to transmit to the future, cannot be guilty of small frauds. They live by a continuity of trade, which detected fraud would spoil. When we scrutinize the reason of the impaired reputation of English goods, we find it is the fault of new men with little money of their own, created by bank “discounts.” These men want business at once, and they produce an inferior article to get it. They rely on cheapness, and rely successfully.

But these defects and others in the democratic structure of commerce are compensated by one great excellence. No country of great hereditary trade, no European country at least, was ever so little “ sleepy,” to use the only fit word, as England; no other was ever so prompt at once to seize new advantages. A country dependent mainly on great “merchant princes” will never be so prompt; their commerce perpetually slips more and more into a commerce of routine. A man of large wealth, how¬ ever intelligent, always thinks, more or less—“ I have a great income, and I want to keep it. If things go on as they are I shall certainly keep it; but if they change I may not keep it.” Consequently he considers every change of circumstance a “ bore,” and thinks of such changes as little as he can. But a new man, who has his way to make in the world, knows that such changes are his opportunities; he is always on the look-out for them, and always heeds them when he finds them. The rough and vulgar structure of English commerce is the secret of its life; for it contains “the propensity to variation,” which, in the social as in the animal kingdom, is the principle of progress.

https://archive.org/details/LombardSt...

[Stephen · Rating 3 out of 5]

This is the first of two books I am reading about financial crises. Originally written in 1873, this volume alludes to the Overends financial crisis of 1866, and sets out the prudent principles that ought to govern the operation of a central bank in the face of a crisis. In our current financial environment, it has much to recommend it.

The Overends crisis of 1866 bears an uncanny resemblance to the collapse of RBS 140 years later. Overends was a bank engaged in the boring, but essential, work of bill discounting in the 1840s and 1850s. The profits weren't spectacular, but they did provide a steady return on capital. Then new management came along, and they wanted to shake things up. To make their mark. The company moved away from the steady work of bill discounting and started to take on the more heady work of railway speculation. Needless to say, the bubble of railway stocks burst, and Overends tumbled with them. However, because of their central role in the discounting of bills, credit froze in London and the house of cards collapsed.

The similarity to RBS is striking. In that case we have established banking brands (Royal Bank of Scotland, NatWest), earning steady returns from boring branch banking. New management looks to spice up the bottom line by engaging in casino banking. Everything works well until the bubble - a property bubble, in this case - pops. Credit freezes and the bank collapses. One key difference between 1866 and 2008 is that the Overends directors had the good sense to ringfence the casino operations to isolate the contagion from the bill discounting business. The geniuses at RBS didn't.

How should a central bank respond to such a crisis? That is the subject of this book. In 1866, the Bank of England made credit freely available, but at a price. Bagehot considers this to be the best possible response, and his views still dominate today. In a policy of what we would now consider as QE, the Bank of England lent freely into the banking sector, but avoided the moral hazard of cheap money by making it relatively expensive. This was to separate those institutions suffering from a liquidity crisis (owing to a mis-match of maturities) from those suffering from a solvency crisis (they were busted flushes).

The book doesn't touch upon how effective this was in 1866, but we now know that the difference between the two can be very fine at times, and that politics helps to determine which is which. Unanswered questions that remain in my mind from our own crisis include, was HBoS solvent when it was absorbed into Lloyds? Did Northern Rock have to be sacrificed? Was Lehman Bros a going concern when Barclays bought the casino banking business? I have no answers to these questions, just ill formed suspicions. What we do know from 1873 is that the resolution of the fall out took decades. Any hope for a resolution in our times, for our crisis, seems like pie in the sky to me.

One final point of interest from the book is the way in which it charts the rise of London as a financial centre. According to Bagehot, the centripetal force in the English monetary system allowed large sums of capital to be accumulated in the London banks, which were then lent to promising ventures, first in England, and then around the world. The routing of capital to find a home at the highest, combined with the impact of leverage upon the balance sheets of the early capitalists, provided the impetus to allow London to rise as the pre-eminient financial centre in 1873. London still retains it's re-eminence today, but one wonders if it might not be compromised by Brexit? That is a question for another day, but the start of an answer is locked away in this book.

The aim of the book was to outline the principles by which the Bank of England should assume responsibility for the English monetary system. It was quite influential in its day, and laid down the basis by which future crises were met - lend freely, but lend dearly. Of course, such principles can only be appraised when they are tested, and that is the subject of the second volume in my reading - the great financial crash of 1914.

[Grace Appler · Rating 5 out of 5]

This book clearly explains, with evidence from history and human nature, the principles of sound banking. It undoubtedly served as a playbook for the central banks in the GFC.

As banking is founded on credit, and credit is destroyed in a panic, the key challenge for a bank is how to fight and survive a panic. According to the book, the answer is adequate bank reserve and brave, effective use of that reserve during a crisis. The peculiar history of Lombard Street leads to the peculiar situation that in England, banks’ reserves are held at BOE instead of at individual banks. Thus, BOE shoulders the burden of providing liquidity in crisis of domestic deposit or foreign cash withdrawal. To fulfil this responsibility, BOE needs sound governance and reserve policy.


Some quotes:

“Organization of capital”: Concentration of money in banks is the principal cause which has made London so exceedingly rich. A million in the hands of a single banker is great power, he can lend it out, the borrowers know where to find him. But the same amount scattered in 10s and 50s around the country is no power at all.

History of banks: their first function was money remittance, helping merchants pay each other over distance through inter-bank accounting. Second function is note issuance, helping public make payments in bank notes instead of hard metal currency. This advertises the banker’s credit and paves ways for deposit banking.

Deposit banking: its essence is that a very large number of people agree to trust a very few people, even maybe one person. Banking would not be profitable if bankers were not a small number, and depositors in comparison an immense number. The distinct function of a banker begins as soon as he uses money of others; as long as he uses his own money, he is a capitalist.

The business of banking ought to be simple. If it’s hard it’s wrong. Banking comes to near to fixed rules as any business. The business of old established bank has the full advantage of being a simple business, and in part the advantage of being a monopoly business (from its prestige).

In a panic, bank should lend as much as possible and as fast as possible to solid credits (those that are solvent but may be facing a liquidity crisis). This is the only way to fight off the panic. The only plan is a brave plan; it may not save the bank, but if it doesn’t, nothing will.

Fluctuations of value of money is greater than fluctuations of price of other commodities. At times there is great pressure to borrow it; other times great pressure to lend it (by bankers who pay interest on deposits).

Central banks have two types of reserve: banking reserve held to meet deposit demand, and currency reserve held to defend currency.

The abstract thinking of the world is never to be expected from persons at high places. A “board” can scarcely ever make improvements, for the policy of the board is determined by the numerous class of its members - its average members - and these are never prepared for sudden improvements.

The life of a man of business who employs only his own capital, and employs it nearly always the same way, is by no means fully employed. Hardly any capital is enough to employ the principal partner’s time, and if such a man is very busy, it’s a sign of something wrong. Either he is working at detail, which subordinates would do better, or he is engaged in too many speculations, and may be ruined. In consequence, every commercial city abounds in men who have great business ability and experience, who are not fully occupied, who wish to be occupied, and who are very glad to become directors of public companies in order to by occupied.

[Robert Morris · Rating 5 out of 5]

Books on banking are like maps of foreign planets. This was one of the first. Bagehot a early editor of the Economist magazine and is still honored with a column title 150 years after his death. These books on finance tend to be short, because the things they describe are so complicated and arcane, that the authors know they can only impose so much on the reader's time. This book was only 164 pages, but I've breezed through 500+ page narrative histories in shorter time. Banking books are daunting, but they must be read to understand the world. This one's a classic.

My main impression from this book is how much has changed. 1870s London was at the center of world finance. It was the first place that could truly say that. Bagehot has captured an interesting point in the evolution from medieval banking to our modern system, but I think it's important to realize that every point is interesting. 1815 London banking was not 1872 London banking, was nowhere near 1945 US banking which is completely different from 2006 US banking which is also very different from 2019 banking, which is very different from 2023 banking.

Bagehot describes a banking system, and central bank practice that is deeply linked to the old fashioned "Bills of Exchange" that I presume the Medici of 1400s Italy would have recognized. They were called Merchant banks for a reason. Trading houses needed to borrow money for transactions across long distances and uncertain time horizons. The "discounting" of these commitments was an art, and the primary business of banking. Bagehot's book goes through all the separate actors in the banking market of the 1870s, in detail that would be boring if it wasn't so vitally important.

Perhaps my most important takeaway from this book is how foreign all of this is to modern practice. The markets for government debt were more or less invented in Bagehot's lifetime. The modern mass real estate securitization, FX markets, government Repo and derivatives that make up much of what banks do today, certainly in dollar terms, were completely unimagined in Bagehot's day. Thinking about it now, I get a little irritated that this book, and Bagehot's advice to central bankers, is seen as having any modern relevance at all.

What Bagehot provides is a snapshot of a time and a place, and a tremendously useful one. His choice to map out the intricacies of one era of British banking is a great gift to historians and to the understanding of confused laymen like myself. I felt a bit bad for Overend & Gurney, the most recently failed bank that keeps cropping up in his analysis. Imagine knowing the name of recently failed Silicon Valley Bank 150 years from now! In writing this book, Bagehot originated a vitally important area of study. But we should keep in mind that his advice to central bankers is desperately out of date.

[Viktor Nilsson · Rating 5 out of 5]

Amazingly clearly written. Central banking is nowadays taken so much for granted that we often ignore what it is all about at its core. This book was written a the perfect point in time (1871) for studying this topic, because this was the time when classic bank-runs still occurred every now and then, when the principles of central banking were being developed and starting to get implemented, and when discussions around this still were at a rather basic level. This was the time when discussion on this topic had become intelligent enough, but still not so concluded as to become some unspoken "best practice".

You could say that we've come a long way since then, and that some of the ideas laid out in this book have since been refuted, and that is certainly true. But most of them still hold, and participating in the reasoning behind those ideas is very educational. If you want to get into quantum physics, you should probably start by reading Newton - in the same way it seems reasonable to read Bagehot to get a foothold in starting to understand modern central banking.

The writing is clear, examples are plentiful, the language is not overly complex despite it being 150 years old. Bagehot does a good journalistic work in presenting different views on some of the theories, and presenting different practitioners and their statements. He also does a good analytical work is synthesizing these views by using and explaining his own reasoning, without getting very dogmatic about it.

I have to say, I was never interested in central banking and I honestly thought I picked up a book about bond trading or something similar. Yet I finished this with delight and I'm quite curious now to know more. Any recommendations are warmly welcomed!

[Don · Rating 4 out of 5]

Walter Bagehot opens this short but pithy classic with a clear, concise analysis of the prevailing realities constituting The Bank Of England, circa 1870, it’s role in the British (and European) economy, its policies, the public and professional expectations under which it performed, and the historical development of its unique governance structure and virtual separation from government direction. He argues succinctly and convincingly that, short of a revolution in England, that the fundamental structure of the bank and the British banking system it served could not practically be altered in those fundamentals. As such, the remainder of the book discusses possible “palliatives” that would be useful in addressing critical vulnerabilities in the Bank’s structures and practices as its role within the banking system had evolved. Bagehot uses clear examples, tight logic, and a ruthless destruction of various proposed, simplistic fixed rules or fixed algorithms for determining targets for reserve funds, decisions about credit rates, and awarding of loans to its client banks.
Bagehot’s own recommendations, which he saw as pragmatic palliatives for the time at which he wrote (not as “truths” to be carried down through the ages to come), are built on this embedded summary sentence:

“The practical difficulties of life often cannot be met by very simple rules; those dangers being complex and many, the rules for encountering them cannot well be single or simple. A uniform remedy for many diseases often ends by killing the patient. (p. 205)”

Lombard Street is an impressive work, informative, historically sensitive, and clearly presented!

[Chris · Rating 5 out of 5]

Why do banks exist, what function do they perform, and under what competitive & cultural circumstances did what kind of individual form them?

Bagehot answers these questions concisely, after decades of reflection and experience. Banks attract small depositors whose funds would individually be too small to lend. They then lend to (hopefully) productive ventures, such as railroad building.




(Note that this was written before the American mortgage, which now comprises much of a bank's loan book.)



A book that proves classics are still read 100+ years later for good reason. And unlike Smith/Keynes, Bagehot isn't famous enough to be classic simply by college syllabi.


Currency and banking are gigantic issues---pick up Homer/Sylla, any of the histories of the Federal Reserve, or any history of the Bank of England, and you'll notice the texts are both huge and full of controversy. If you want a 50-page start to currency/banking/finance/lending/etc., you could do worse than starting with Bagehot.





The political times that formed Walter Bagehot also formed The Economist magazine.

[Paul Kearns · Rating 1 out of 5]

An insight into the early structure of the money market, its participants and the attitudes within and towards the Bank of England.

It shows how basic the financial system was, from which you can identify how various crises and cases of misconduct have since occurred. It also presents the genesis of ideas that have since advanced as financial subjects, such as Asset Liability Management, Liquidity Adequacy and Treasury Management.

However, outside of a history lesson, I found that there is little to be learnt from the book. Whilst it may have been progressive at the time, it is hard to imagine it being by any stretch revolutionary.

Personally I found it to be a hard slog to get through - a real eye-roll moment when, in the final chapter, he writes “I fear I must have exhausted my reader’s patience”. Yes, Walter, you have.

An essay for those working in the industry with an interest in the history (my only excuse). Otherwise, for those looking a more progressive read on central banking, I highly recommend ‘The End of Alchemy’ by Mervyn King.

[Tomáš Kreuzinger · Rating 3 out of 5]

While Bagehot's insights are remarkable and fascinating, especially looking back at the state of 19th century knowledge of the financial markets, one must also take into account the density of information and Bagehot's propensity to repeat himself. If he had been more austere with the choice of his examples this book could have been half the length. One feels lost in the additional pages of whom the ultimate idea is still the same: "a reform of the financial markets and reevaluation of our current value structures"

[Max Lybbert · Rating 4 out of 5]

This is a classic economics monograph that is constantly quoted by people at the Federal Reserve. Unfortunately, they all quote the same passage of how to operate a lender of last resort.

Despite its age, the book remains highly readable and, at least for me, somewhat entertaining. Some details about the Bank of England have changed in the last century and a half, but it’s very telling, if somewhat depressing, that the Federal Reserve’s economists don’t have a better book to quote from.

[Simon Riddell]

A legitimately fascinating read. You can see how historical or 'primitive' money-markets had all the same properties we have today. It's often useful to look at these historical "simplified" markets, since you can better identify the core components that go into managing monetary systems. It can be overwhelming to start with current systems, since they are so complex. Yet that complexity doesn't change the underlying simple dynamics.

[John · Rating 4 out of 5]

Bagehot is such a clear thinker that I understand why this is still a classic in the monetary policy world. Some great observations. Of course, we've moved off the gold standard so some of his logic simply isn't applicable any more. Sorting through what is and isn't applicable was the biggest challenge for me. Overall, some great monetary policy history, plenty of timeless insights and principles, and sorting through what remains relevant improved my understanding of our modern system.

[Basili · Rating 4 out of 5]

A theoretical book about the English banking system, Lombard Street is a densely book that is impressively important and relevant today. The book is a collection of 11 essays that details all facets of the banking system. The historical construct of the late eighteen hundreds banking system is a little much, but the work overall highlights the fragility and complexities of the financial system.